Essays on the theory of tax evasion

View/Open

Date

Author

Metadata

Abstract

Literature on tax evasion has generally ignored the effects of tax evasion by a monopolist in a regulatory environment. When the government is asymmetrically informed about the monopolist's
demand and/or costs, however, the fIrm may have the opportunity to cheat on its regulatory constraint
and tax payments. Adjustments in the regulatory constraint then will directly impact on the
tax revenues of the government while alterations in tax policies may alter the effectiveness and efficiency
results of a particular regulatory policy. To analyze these issues two forms of regulation,
a price ceiling regulation and a fixed profit per unit regulation are considered in an environment
where the government is incompletely informed about the monopolist's cost function.
For the price ceiling regulation (Chapter 2) it is shown that tax evasion decisions are affected by
variations in the ceiling in the sense that an increase in the effective price ceiling results in
misreporting by a larger proportion. Tax evasion decisions however are found not to affect output
decisions of the monopolist. Thus the optimal price ceiling under evasion is set at the same level
as without tax evasion, i.e., at the point where price equals expected marginal cost. Optimality in
this economy can be achieved in a number of ways. Full compliance is one way but optimality can
also be achieved with tax evasion.
When the form of regulation considered is a fixed profit-per-unit regulation (Chapter 3), the results
are quite different from above. Because profits of the monopolist are not costlessly observable by
the government, fIrrns can cheat on the regulatory constraint itself. Thus output and tax evasion to affect the monopolist's output.
Literature on tax evasion has often neglected the fact that income from different sources is taxed
at different rates and provides different opportunities for misreporting. Once an individual obtains
certain skills, his flexibility in switching jobs to evade taxes on his wage income becomes limited.
Also the fact that a large part of the wage income in the U.S. is reported to the government by the
employer and often withheld at the source, greatly limits the opportunity for evading wage taxes.
However an individual faces many options when deciding on how to invest his savings and the income
from at least some of these may not be subject to withholding and reporting. This fact suggests
that the savings of an individual can be affected by tax evading opportunities. Chapter 4
examines this problem by considering a dynamic model of tax evasion. The results show that an
increase in the penalty rate or audit probability leads to an increase in savings of the individual,
given some assumptions on preferences. This fact implies that savings are reduced by the possibility
of tax evasion. It also suggests that savings could be increased by stricter enforcement of tax laws.
Because the model used in chapter 4 is fairly complicated, some of the comparative static results
are found to be ambiguous under general conditions. It is also not clear from the theory what the
optimal policy of the government would be. To address these issues in more details, chapter 5
considers some numerical exercises. A number of results emerge from these exercises. First, savings
are found to increase with an increase in either the penalty rate or the audit rate, even when the
restrictive assumptions on risk aversion do not hold and labor supply is variable. Second, full
compliance seems to be the optimal policy of the government for the specification selected. These
results seem to hold both for compensated and uncompensated taxes.